Curve

Here’s why the Fed is relentlessly pushing rates lower – and how it affects you

Peter Miller
The Mortgage Reports contributor

Economic pressure on the Fed can trickle down to consumers

The Federal Reserve is about to make a decision. Keep bank rates where they are, or lower them by a quarter or even half a percent.

This decision isn’t made in a vacuum. The Fed is feeling pressure to lower rates from many sides.

The U.S.-China trade war, signs of a coming recession, and POTUS himself all play a hand in pushing bank rates lower.

A lower bank rate could be good news for consumers. Oftentimes, it means lower interest rates on lines of credit and higher returns on savings.

However, neither a Fed rate drop nor lower rates for consumers are guaranteed. The impact on your wallet will depend on what happens in the Fed meeting tomorrow and its aftermath.

Lock today's already-low mortgage rates. Start here. (Oct 18th, 2019)

Why the Fed tinkers with the federal funds rate

The Fed is an important bank regulator. It tries to keep the economy humming along without too much or too little inflation.

One tool the Fed uses to this end is the federal funds rate. That’s the interest rate banks pay to one another for overnight borrowing.

The Fed can raise or lower the federal funds rate in an effort to speed or slow the economy.

Take the housing crash, for example. In 2006 the federal funds rate was at 5.25%. Then foreclosure levels began to soar and the economy rapidly collapsed. By 2008 the federal funds rate was near 0%.

Why did the fed lower bank rates during the crash? To increase lending and get the economy restarted.

The Fed has raised the federal funds rate 10 times since late 2015. Now, on the cusp of 2020, we’re seeing rates fall again as many worry that the economy is starting to slow down. For that reason, the Fed is likely to lower rates at the September 18 meeting.

Reason #1: Pressure from Trump to reduce rates to “zero or less”

The Federal Reserve describes itself as “an independent government agency but also one that is ultimately accountable to the public and the Congress.”

President Trump, however, wants the Fed to lower bank rates significantly. He argues that the “Federal Reserve should get our interest rates down to ZERO.”

The president likely has three reasons for favoring such a drastic cut.

First, the federal government has over $22 trillion in debt as of mid-September. The general interest rate is 2.525% according to the Treasury Department. In a single year, the interest bill is roughly $570 billion. A 1% interest rate drop cuts the deficit by more than $220 billion. Zero-interest means the government saves more than half a trillion dollars per year.

Zero-interest means the government saves more than half a trillion dollars per year.

Second, calling for lower interest is politically popular. You don’t make friends arguing for higher mortgage payments.

Third, the president is a real estate developer. He knows about mortgage borrowing. Like any other mortgage borrower, he knows that lower rates increase affordability and potential profits.

Reason #2: To fight off a potential recession

An inverted yield curve in August set recession alarm bells ringing.

What’s an inverted yield curve? It’s when short-term bonds carry higher interest rates than long-term ones.

In recent weeks the yield curve has been inverted. In August, according to CNBC, the interest rate for two-year Treasury securities was 1.634 while the rate for a 10-year note was 1.623%.

An inverted yield curve is generally seen as a sign of recession. However, you don’t need an inverted yield curve to think that recession might be around the corner. A lot of economists think the current expansion will end in 2020 and that we will then have a recession as the economy contracts.

The Fed can use a lower federal funds rate to stimulate the economy. It’s a pre-emptive strike to fight off a potential recession.

Reason #3: Combat effects of the ever-changing U.S.-China trade war

The United States is now engaged in a trade war with China. Where it goes, and how far it goes, are unclear.

However, because China is our largest trading partner the impact of a trade war on our economy (and theirs) can be significant. The uncertainty created by the trade war makes economic planning by the Fed enormously difficult. 

This is because the status of trade can change quickly; a tweet from the president can announce new tariffs and send markets reeling. How does the Fed — which meets about every six weeks — prepare for any scenario?

To be safe, the Fed might cut the bank rate to offset economic damage from trade wars.

What the Fed cut may (or may not) mean for you

It might seem pretty straight-forward. If the Fed lowers bank rates your costs for mortgages, auto loans, and credit card borrowing should go down. Rates for home equity lines of credit — HELOCs — should fall.

If bank rates decline then surely mortgage rates should also fall. Sounds good in theory. In practice, the impact of a Fed rate cut on mortgages might be a lot less than anticipated.

Mortgage lenders have already “priced in” a Fed rate cut. So today’s mortgage rates will likely not be affected if the Fed proceeds as everyone expects with a 0.25% cut.

And, contrary to popular belief, the Fed doesn’t control consumer mortgage rates. It can influence them, but at most points in history, the effect of a rate cut has been small.

Here’s the good news. While the Fed has been raising bank rates, mortgage borrowers have seen their rates decline. In August the typical mortgage interest rate was 3.62% according to Freddie Mac. Back in December 2015 borrowers were paying 3.96%.

Your next steps

In the past week or so mortgage rates have risen. Such “higher” mortgage rates need to be kept in perspective. They remain well below 4%.

Historically, 4% is less than half the 8.08% rate paid by borrowers from 1971 through the end of 2018.

Lock in today’s ultra-low mortgage rates. Get started below.

Verify your new rate (Oct 18th, 2019)